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November 26, 2012

Hedge Funds Badly Beaten by S&P 500 Performance

Just 13% of hedge funds are beating the broad market indicator

Low cost indexing might have been vindicated in the starkest way possible. According to Goldman Sachs data, just 13% of hedge funds are outperforming the S&P 500, and a fifth of all hedge funds are actually in the red during 2012.

To make matters worse, hedge fund managers have crowded into the same trades, with turnover at a record low, Goldman reports.

What does this mean?

“Hedge fund investors are paying 2% fees up front and 20% of profits thereafter to managers delivering poor performance and apparently doing little about it,” CNBC said Monday, when discussing the report.

"Many hedge funds turned into mutual funds–but with higher fees and worse performance–this year," Mike Murphy, who runs hedge fund Rosecliff Capital, told the network. "Hedge funds have underperformed because they have been hedging against a massive market correction as the memory of 2008 is still fresh in everyone's mind."

"It's been a tough year, but better times are ahead," added Murphy.

As CNBC notes, the S&P 500 was up 14% through November, while the average hedge fund posted just a 6% return over the same time period. Meanwhile, the average large-cap mutual fund has returned 13%.

"Hedge fund returns are highly dependent on the performance of just a few key stocks," wrote Amanda Sneider, author of the report for Goldman. Examples given include Apple (AAPL), Google (GOOG), AIG (AIG), Microsoft (MSFT) and Priceline.com (PCLN).

"Turnover of all hedge fund positions averaged a record low of 29% during 3Q 2012, well below the 10-year average of 35%," she added.

It's not just closet indexing leading to this underperformance, CNBC argues.

“Record low interest rates globally have led to high correlations between stocks, bonds, gold and currencies, making it difficult for hedge fund managers to separate themselves from the rest of the pack.”

As the network notes, Goldman's analysis is based on a rather large sample size, using the latest available public filings from nearly 700 hedge funds with $1.3 trillion under management.